Are experts' expectations rational? A multicurrency analysis
Is the exchange rate expectation formation process rational? This age old question is looked at with survey data on exchange rate expectations at multiple forecast horizons. This helps to circumvent the risk premium issue and isolate the exchange rate expectational rationality factor. The econometric procedure used is the Phillips-Hansen fully modified ordinary least squares test. This allows one to conduct an unrestricted cointegration analysis and also differentiate between strong and weak forms of rationality. To do this separate tests are made of the bivariate (two currencies) and the multivariate (multicurrency) systems approach. Rationality in the exchange rate expectation formation process is not upheld in either the weak or strong form test, at any forecast horizon.